Pension savers have choices over retirement income, but insurers do not make
this clear – and they profit from the confusion.

Tens of thousands of savers are led into buying poor-value insurance to provide income for old age by firms that refuse to offer legitimate – and often better – alternatives.

An investigation by The Daily Telegraph found that half of Britain’s 20 major pension providers failed to offer vital options to savers turning their pension into income.

They instead promoted “annuities” – the insurance under investigation by the City watchdog. Last week, a damning report condemned some annuity selling as tantamount to “burglary”.

Nearly 400,000 people will have bought an annuity to provide old age income in 2013. Critics said large numbers were led into an irreversible “trap” that will leave them short-changed.

One major insurer admitted that anyone with more than £50,000 in a pension should have considered the alternative to annuities, called “drawdown”. Here, rather than handing your life savings to an insurer for a fixed income, you can take as much as the whole pot as cash, or keep it invested while making withdrawals.

Yet analysis of official data suggested 80,000 people with pensions worth £50,000 or more purchased annuities last year.

Ros Altmann, a former consultant to the Government on pensions, said: “The system is stacked against the customer; it is biased toward people getting the best rate on an annuity immediately, rather than the most appropriate route to retirement income for them.”

This week, an independent advisory group working alongside the Financial Conduct Authority issued a damning critique of annuity sales. The Financial Services Consumer Panel was concerned about “exploitative pricing” and “opaque charges” by insurers and salesmen. It said the process of taking pension income was so complex that savers made “irreversible” mistakes, with insurers pocketing “excessive” profits.

Since 2011, it has been every saver’s right to leave their pension invested while taking income. This income is subject to a cap for most people – currently £7,080 for each £100,000 held by a 65-year-old, a figure almost £1,000 higher than the best annuity for a healthy person.

Drawdown is riskier than an annuity, as poor investments can deplete your fund rapidly, and there are typically extra charges.

But it is often ideal for savers with several income sources; unlike an annuity, you can take tax-free cash without touching the remainder until needed, vary your income and pass the pot to family as inheritance.

Crucially, savers with a generous final-salary scheme – or a large pension income elsewhere – are able to go a step further and treat their pension like a cash machine. This is a special form of drawdown called “flexible drawdown”. To qualify you must show £20,000 of pension income from other sources. This includes the state pension, which for some people pays more than £14,000 a year.

Yet of the 20 firms questioned by Your Money, more than half failed to offer this flexible option. The list included Prudential, Aviva, Scottish Widows, Royal London and RBS. A fifth refused to offer even basic drawdown, while others made only passing reference in the literature sent to customers at retirement. Industry figures show that just 57 drawdown policies are taken out a day, compared with 1,000 annuities.

Malcolm McLean of Barnett Waddingham, the pensions consultancy, said: “Savers are led to think they are forced down the annuity road, and there’s nothing else they can do. The options are not publicised well enough and the system is too rigid.”

Even insurers that did offer flexible drawdown often demanded a minimum pension of £50,000. This was no use to someone who retired with £20,000 in main pension income and a small nest egg on the side – not uncommon among baby boomers.

Insurers are required to point savers toward a middleman who can “shop around” the retirement options. But increasingly, this has meant brokerage firms, most of which only sell annuities. These firms earn up to 6pc commission for selling annuities, or £12,000 from each £200,000. This fee is factored into lower annuity rates for customers.

The alternative is to turn to financial advisers, who, due to a rule change in January, are no longer incentivised to sell specific products. But for some, the upfront fees – which range into thousands of pounds – are too onerous. Transferring a pension to another company alone can cost hundreds of pounds.

Your Money readers complained they felt forced into buying an annuity. Chris Hicks, 66, from Redhill in Bristol, found his path blocked when he attempted to take a personal pension worth £3,125 via flexible drawdown. Mr Hicks qualifies due to income of £18,223 a year from a local authority pension and just over £6,000 from the state.

He said: “The insurance companies seem either unwilling or unable to provide a flexible drawdown facility for anything like an economical amount, given the size of my fund.”

Mr Hicks took a miserable payout of around £15 a week from Prudential.

Geoff Tagg also baulked at the cost of using flexible drawdown when arranging his affairs ahead of his 65th birthday in February. Mr Tagg, from King’s Lynn in Norfolk, has pensions of £80,000 with Aviva and Scottish Widows, neither of which offer flexible drawdown. The charity worker has comfortably met the £20,000 income requirement since taking a final-salary pension in 2004.

He said: “All the insurance companies need to do is check the applicant meets the criteria, then send a cheque. I suspect the real reason they don’t offer flexible drawdown 30 months after the rules were introduced is they can’t take any ongoing fees if the customer withdraws all the money.”

The Association of British Insurers said its members have been alerting customers to all their options since March.

Which type of pension suits you?

If you can afford it, taking expert financial advice when you retire is worth every penny. Your unique circumstances will determine whether an annuity or drawdown is the right option. If all your pensions (outside the state pension) tally less than £18,000 you can take the lot as a lump sum, with 25pc tax-free.

Those with money saved up can take up to two pots worth less than £2,000 as cash. Tom McPhail of the Pensions Income Choice Association is lobbying the Government to increase the limit to £15,000.

Those with £50,000 or more should speak to an independent financial adviser, as splitting some or all of the pot into drawdown could work well. It pays to get help setting up your portfolio. Visit unbiased.co.uk .

However, no matter how big your fund, stick to an annuity if you can't stomach any risks that your income might fall in old age. Shop around the whole of the market, as annuity rates vary wildly. Declare all your medical conditions, as this can increase your income. Consider how your spouse would survive if you die, as a "joint-life" annuity will continue paying out for extra cost.

Finally, compare the rate found by the middleman with your existing provider's offer, as some policies include valuable annuity rates worth £10,000 a year from each £100,000 saved.

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